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Question: Recently, I have been discussing with some prospects about franchising my brand. They want to know how much they can make operating one of my restaurants. What should I tell them?
Answer: It makes sense that a prospective franchisee would want to first know how much they can make operating your franchise. However, remember that all disclosures about your franchise offering are regulated by the Federal Trade Commission’s Franchise Rule and over a dozen individual states. Remember that these statutes and regulations generally require that you disclose all of the financial and other risks of purchasing a franchise from you before the prospect purchases a franchise in the form of a Franchise Disclosure Document (FDD). These pre-sale disclosure regulations are no more applicable than to the issue of financial performance representations.
Financial performance representations are not required to be made to prospects. However, if a franchisor makes a financial performance representation, it must be made in the body of the FDD. We call these “Item 19 Disclosures” because if a franchisor makes a financial performance representation, it must be made in Item 19 to the FDD. Strict compliance with this obligation is required more today than ever before.
In February, a federal court in Virginia considered a dispute between a franchisee of Bans Pasta and the franchisor relating to the franchisee’s allegations that Bans Pasta violated the FTC Franchise Rule by providing a financial performance representation outside of the FDD. Although a franchisee cannot sue a franchisor for violations of the FTC Franchise Rule (because there is no “private right of action” for violations of the FTC Rule … only the FTC can enforce the FTC Rule), the Virginia federal court allowed the franchisee to proceed under a negligence theory because the FTC Rule set the standard for franchisor performance. The court reasoned that since the FTC Franchise Rule sets the standard for disclosure of financial performance representations, Bans Pasta had a duty to comply with that standard and that by making financial performance representation outside of that standard constituted actionable negligence. See Bans Pasta, LLC v Mirko Franchising, LLC, 2014 U.S. Dist. LEXIS 19953 (W.D. Va. Feb. 12, 2014).
Although this case is in Virginia and was analyzed under Georgia law, it should provide franchisors and prospective franchisors all over the country further evidence that strict compliance with the FTC Rule and the various state franchise rules is mandatory, especially for the franchise sales staffs and independent brokers who are on the front lines of meeting with franchisee prospects.
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